Stevenage Accountant T: 0845 643 1825 | E: info@eebusiness.uk.com


CORPORATE GOVERNANCE

WHAT IS CORPORATE GOVERNANCE?

  • In many organisations, those controlling it are not the same people who own it.
  • In the largest organisations, owners may have such small individual stakes that:
    1. They do not care too much what the organisation does.
    2. They are not prepared to challenge the directors.
    3. They do not have the power to challenge the directors.


  • The biggest owners are often institutional shareholders – for example, pension funds
    1. They are investing money on behalf of others – it is not theirs.
    2. They tend to be “inactive” by nature, preferring not to “rock the boat”.


  • Globalisation has resulted in the biggest companies / organisations becoming even larger than in the past – which is making the above issues even more important.
  • Recent corporate disasters and the apparent increase in corporate fraud and unethical business behaviour have lead to a lack in trust in directors.

This all leads to the AGENCY PROBLEM.

 

The agency problem:

In simple terms, if you want something done properly, the way you want it done … Do It Yourself!

Agents are people employed to do something for you. The risk is that they do it for themselves…

Agency Costs

If you employ someone to do something for you, additional costs will arise:

  • The agent will expect to be paid for their work
  • The agent may expect additional benefits
  • A nice office
  • A company car
  • To travel first class while doing your business
  • You will have to spend some time and effort monitoring the agent to ensure they are doing what you want … and the less you trust the agent, the more checking you will want to do!



Corporate Governance is a series of laws or guidance aimed at making directors manage companies in the best interests of shareholders, and other stakeholders.

In other words, it is an attempt to deal with the agency problem.

Who sets the rules?

  • Global – the OECD have developed a Code (Organisation for Economic Co-operation and Development).
  • National – many countries have developed their own systems, sometimes as laws (e.g. Sarbanes-Oxley in the USA) and sometimes as a Code (e.g. Combined Code in the UK).
  • Companies – many companies have tried to develop their own policies on Corporate Governance, some of which go further than the rules or Code their country expects them to follow.
  • Other – in some countries, something that appears to be “voluntary” can effectively become law (e.g. in UK all listed companies are required to either follow the Combined

 

Underlying concepts behind corporate governance

These are the fundamentals behind how companies (and more importantly those involved with companies, primarily directors) should behave.

  1. Fairness: All people affected by decisions (stakeholders) should be treated with equal consideration.
  2. Openness / transparency: All information should be made available to stakeholders, and in a clear manner. This may suggest companies should not just follow disclosure rules, but also add voluntary disclosures if it adds to transparency.
  3. Independence:All those in a position of monitoring should be independent of those / what they are monitoring:
    • Non-Executive Directors should be independent of the Executives, and of company operations
    • External auditors should be independent of the company, especially its accounting department and processes.
    • Internal auditors should be independent of the company, as they are likely to be involved in monitoring systems throughout the company’s operations.
  1. Probity / honesty: This is not just telling the truth – it also means finding out the truth, not ignoring it (not “turning a blind eye”).
  2. Responsibility: Directors should understand and accept their responsibility to shareholders and other stakeholders, and act in their best interests … and be willing to accept the consequences if they fail in this responsibility.
  3. Accountability: This links with responsibility. Directors must be willing to be held accountable for their actions – and shareholders cannot exercise their own responsibility (as owners) unless they have this information available.
  4. Reputation: Directors must protect their own reputation, and that of the company they run, as damage to either is likely to lead to more widespread damage to the company.
    This raises an interesting debate about whether a director’s private life is in fact private – since a bad personal reputation is likely to affect their business reputation and hence that of the company.
  5. Judgement: Directors must ensure they have all the necessary information and understanding in order to be able to make sensible business decisions that improve the prosperity of the company.
  6. Integrity: This is quite a general term and has a crossover with some of the other terms above. Integrity means honesty, fair-dealing, presenting information without any attempt to bias opinion … and in a more general sense, “doing the right thing”.

 

THE MAIN AREAS OF CORPORATE GOVERNANCE

Using the UK Combined Code, the primary areas of Corporate Governance are as follows:

 

Directors: An effective board of directors should:

  • Lead company strategy.
  • Include Non-Executive Directors (NEDs) who:
    • to contribute to strategy.
    • assess performance of the Executive Directors.
    • Oversee integrity of financial information, control systems, and risk management.
    • Decide remuneration of the Executive Directors.
    • Appoint, remove, and consider succession planning of Executive Directors.
  • Should meet regularly, with a formal agenda.
  • Should detail its membership (including Chairman, CEO, Senior Independent Director, Committee members) and work in the Annual Report.
  • Should ensure Chairman and NEDs meet without the Executives, to consider their performance.
  • Should ensure NEDs meet without Chairman annually, to consider the performance of the Chairman.

Chairman and Chief Executive Officer (CEO):

  • Should not be the same person.
  • Chairman leads Board, and sets agenda for Board Meetings.
  • Chairman is key contact for shareholders.
  • Chairman is Independent on appointment.
  • Chairman is not the former CEO of the company.
  • CEO runs the company.

Board balance:

  • No one person, or group, should be able to dominate the Board.
  • At least ½ the Board, excluding the Chairman, should be Independent NEDs.
  • Should be an appropriate balance of skills and experience.
  • Annual Report must detail which NEDs are considered independent.
  • Should appoint a Senior Independent Director – so shareholders have an alternative to talking to the Chairman.

Appointments to the board:

  • Nomination Committee, majority of whom are Independent NEDs.
  • Chaired by Chairman (unless Chairman is being discussed).
  • Have criteria for selection of new Board members.
  • Report its work in the Annual Report.
  • Organise induction and training for all directors.

Annual performance review:

  • Board, its committees, and individual directors should have performance appraised at least annually.

Re-election of board members:

  • At 1st AGM after appointment to Board, and at least every 3 years afterwards, by shareholders.

Remuneration of directors:

  • Enough to attract, retain and motivate.
  • Significant proportion should be performance-related.
  • Should consider industry pay levels.
  • NED remuneration should not be performance-related, but should reflect time involvement of the role.
  • If a director is removed before the end of contract, provisions should be in place to ensure they are not over-compensated for failure.
  • Notice periods no longer than 1 year.

Remuneration committee:

  • At least 3 Independent NEDs as members.
  • Should set remuneration of all executive directors and the chairman, and senior management.
  • Remuneration of NEDs is flexible – could be by Board as a whole, by shareholders, or a separate Board Committee.
  • Shareholders must approve any long term share options.

Financial reporting:

  • Board should present a balanced assessment of company’s position and future prospects.

Internal control:

  • Board should ensure a sound system of Controls.
  • Annual review of effectiveness of Controls, and report this in Annual Report.

Audit committee and audit:

  • Audit Committee of at least 3 Independent NEDs.
  • At least 1 member to have recent relevant financial experience.
  • Main role is liaison with the internal and external auditors on all matters.

Relations with shareholders:

  • Regular dialogue with shareholders.
  • Chairman to ensure shareholder views communicated to Board.

Constructive use of AGM:

  • Communicate with investors.
  • Encourage debate.
  • Allow the use of proxy votes.

Institutional shareholders:

  • Should themselves ensure dialogue with directors.
  • Should make considered use of their considerable voting power.